The IRS Spelled Backwards: Why Taxes Are Your Largest Retirement Expense, and What to Do About It

By: J. Barry Watts, Expert Tax Strategist and Retirement Designer

Taxes are my favorite thing to talk about, and I realize how strange that sounds. Here is the reason. Taxes are the one area of retirement planning where I can move the needle profoundly for a family, and almost nobody who walks into my office has any idea how much is on the table. They have never been shown. That gap between what people pay and what they have to pay is, for a great many households, the single largest sum of money still available to them.

My co-host on the television show, Ralph Hipp, likes to point out that the word theirs is spelled T-H-E-I-R-S, which is to say the IRS is sitting right there in the middle of it. The entire purpose of tax strategy is to move that money from theirs back to ours.

You Have More Control Than You Have Been Told

There is an enormous amount in life we cannot control. The weather. The stock market. The traffic on Glenstone. Most people file their retirement tax bill in that same category, as weather, as something that simply happens to them. That is not entirely true, and the difference is worth real money.

You have considerable control over what you pay in taxes, and you have the most control in the years before you retire. Make a few critical decisions in that window and you can save hundreds of thousands of dollars across your retirement. Yet every year, households across Southwest Missouri collectively pay an enormous amount of tax they were never required to pay, for one reason: they did not know they had options. They did not know there was another way to read the tax code, and they did not know that the IRS is not something to be feared if you have the right representation and the right planning behind you.

Taxes Are Your Number One Expense in Retirement

People are genuinely startled when I tell them that income taxes will likely be their largest single expense in retirement. Larger than housing. Larger than healthcare. The reason it catches everyone off guard is that taxes are insidious. They do not arrive as one enormous bill you can see coming. They take a bite this year, and another next year, and another the year after, and almost nobody adds up what that amounts to across a thirty-year retirement.

The deeper problem is that most people arrive at retirement having done no tax planning whatsoever. Not because they were careless, but because nobody told them it was something a person could do.

The Rearview Mirror and the Front Windshield

Here is the distinction I wish every retiree understood. You may well have a CPA who prepares your return beautifully. That person is a tax compliance professional. Their job is to keep you in compliance with the IRS, to track what already happened and record it correctly on the proper government forms. It is necessary work and I would not want to do without it.

But compliance is historical. To actually save money, somebody has to be proactive. You need a tax strategy that looks forward. I put it this way: a CPA looks in the rearview mirror, and a tax strategist looks through the front windshield at what is coming, so there is still time to make adjustments to what eventually gets reported to the IRS.

Those adjustments are made using the favorable rules already written into the tax code, which is the part that surprises people most. These are not loopholes and they are not tricks. They are provisions Congress put there on purpose. They are simply not part of the standard CPA curriculum. Those of us who are educated and credentialed by the IRS itself do learn them, and that is where the savings come from.

That is a good deal of what we do differently at WealthCare Retirement Solutions. Some of our clients end up in a position where their retirement income is effectively tax free, sitting in the zero percent bracket. Not everyone can get there, and I will not pretend otherwise. But if you cannot reach zero, we work to get you into the lowest bracket available to you, and for every single household that is money saved.

You Do Not Have a Million Dollars

Let me take away something you may be fond of. If you have a million dollars in your IRA and you feel good about that number, I would gently suggest that you do not actually have a million dollars. You have something closer to six hundred fifty thousand. Uncle Sam has roughly three hundred fifty thousand of it, and he is simply storing it in your account and letting you enjoy the feeling that it is yours.

For a lot of people, that one sentence is an epiphany. And it leads directly to the strategy: get divorced from Uncle Sam as early as you reasonably can. Pay him off, get him out of your life, and move through retirement without him as a silent partner in every withdrawal you make.

There are a great many ways to do that. They are complicated enough that I cannot do them justice in a single article, but the scale is worth stating plainly. We are not talking about a thousand dollars here or there. We are talking about tens of thousands of dollars a year, hundreds of thousands across a decade, and in some cases a quarter million or half a million dollars over a lifetime. That money stays in your family. You live on it, and if you do not need it, your children receive it. Either outcome beats sending it to Washington.

Strategic Roth Integration

We use well over a hundred different tax strategies with clients, and one of the most popular is what we call Strategic Roth Integration, or SRI.

The name is a small joke that has stuck. We dislike the institution of the IRS so thoroughly that we took the three letters and turned them backwards. I want to be careful here, because we have nothing against the people who work there. Several of them are friends, and our own CPA at WealthCare spent part of his career at the IRS, which means he knows precisely how the agency thinks. It is the institution we are arguing with, not the individuals.

The logic behind SRI is simple enough to state in a sentence. If tax rates are higher in the future than they are today, then it makes sense to voluntarily pay tax now, at today’s rates, while moving money out of tax-deferred accounts and into accounts where it will never be taxed again. My own expectation is that rates are more likely to rise over the course of a long retirement than to fall. Tax law changes on a schedule that has nothing to do with your plans, so the specific rates and deadlines should be checked against whatever the law says in the year you read this. The planning principle holds either way: move the tax bill to a year you choose, rather than a year the government chooses for you.

Clients who pay their taxes voluntarily at today’s rates frequently save six figures in income tax over their lifetime. A quarter million or even half a million dollars is not unusual in our practice, which is far more than most people imagine they will ever pay in the first place. You cannot fix a problem until you know you have one, and this is a problem most retirees do not know they have.

Required Minimum Distributions: The Day You Lose the Driver’s Seat

Required minimum distributions have an enormous effect on what you pay, and the reason is control. An RMD is the moment you lose authority over your own IRA. The government decides how much comes out, when it comes out, and what rate you pay on it.

Under current law, if you were born in the 1950s, required minimum distributions begin at seventy-three. If you were born in 1960 or later, as I was, they begin at seventy-five. Congress has moved those ages more than once in recent years, so confirm the one that applies to you.

Everything before that age is yours to direct. You decide whether to take money out of your IRA. You decide how much tax to pay and when to pay it. A good tax strategist can use those years deliberately, keeping you in low brackets now and clearing taxes out of the way so you are not forced into higher brackets later.

Once you hit RMD age, the government tells you to move over. You are no longer in the driver’s seat. They dictate the timing, they dictate the amount, and the tax code in force at that moment dictates the rate.

Why a Second Opinion Matters

If your current advisor does not offer a forward-looking, tax-efficient retirement plan, getting a second opinion is not optional in my view. It is critical.

Most people are taking retirement advice from investment salespeople. Ask one of them a tax question and the answer is almost always the same: you’ll have to ask your CPA. We do not do that to our clients. When a client sits down at our table, they are sitting across from a tax strategist, and frequently there is also a CPA in the room who spent years working for the IRS and knows every trick in the agency’s bag. His office is about fifteen feet from mine, which is exactly how close that expertise ought to be.

We build strategic tax plans for retirees routinely, and routinely save them six figures over a lifetime. We had clients call just this week who are selling a business for a genuinely remarkable sum, and the planning we are doing will reduce the tax on that sale dramatically. They came to us knowing we handle this kind of work. What they did not know was how much difference it would make. Results in any particular case depend entirely on the facts of that case, but you have to know the tax law to find the opportunity at all.

This Week’s Steps to Confidence: The Icebergs Under Your Retirement

To retire successfully and stay retired, you have to see and avoid the icebergs that can sink the ship.

If you have been to the Titanic Museum down in Branson, you understand how quickly this happens. Smooth water, good speed, and something hidden beneath the surface opens the hull. I recommend the museum, by the way, and take the family. When you walk in they hand you a card with the name of an actual passenger on it, and you go through the entire exhibit as that person. At the end, you find out whether your passenger lived or died. At WealthCare Retirement Solutions, we want every passenger on our ship to make it to one hundred, with income that lasts the whole voyage.

Remember that an iceberg is roughly ninety percent below the waterline and only ten percent above it. Most of what can damage your retirement is in the part you are not looking at, which is precisely why you want somebody whose job is to point at the water.

Iceberg one: there is more than one tax

We have already covered income tax, but income tax is not the only one. Your Social Security can be taxed as well. When the program began there was no tax on benefits at all. Over time the federal government began taking bites, and today as much as eighty-five percent of your benefit can be subject to income tax. Here is the connection most people miss: required minimum distributions from your IRA can be the very thing that causes your Social Security to become taxable.

Iceberg two: your ugly Aunt Irma

IRMAA stands for income-related monthly adjustment amount, which is government language for part of what you pay for Medicare after sixty-five. Some people believe Medicare is free. It is not. Beginning the month you turn sixty-five you pay for your healthcare every month, and the higher your income, the higher that payment climbs.

Put the two icebergs together and the shape of the problem appears. If you do not manage your IRAs to minimize taxable income, the money coming out of those accounts raises the tax on your Social Security and raises what you hand to Aunt Irma. Some couples end up paying a startling amount each year for government healthcare, entirely because nobody managed the taxes back when they were still manageable. The thresholds adjust annually, so check the current year’s figures before you plan around them.

Iceberg three: the long-term care plan that is not a plan

The cost of care is the iceberg people most want to steer around by not looking at it. A great many people who sit in my conference room have, in effect, crossed their fingers and hoped to die peacefully in their sleep. That is a fine way to go. It is not a plan, because you do not get a vote.

I talk to a lot of men who rear back in the chair, elbow their wife, and tell me she is the long-term care plan. It is said affectionately and it is almost never realistic. Can she physically lift you, reposition you, get you into the shower and manage all of that several times a day, every day? In most cases the honest answer is no.

I know it’s a no in my own house. I am a fairly robust fellow and my wife is small. She is a registered nurse and knows exactly how to care for old guys, but she does not have the muscle to move me around. So we built ourselves a retirement income and long-term care plan, the same kind we build for clients. When I showed it to her, what she said was that it gave her the money to pay for the muscle. She could direct the care, and somebody else would do the lifting.

I hope we never need it. I am still planning on dying in my sleep and waking up somewhere considerably better. But if it does not go that way, we have an answer ready, and so should you.

The Bottom Line

Taxes in retirement are not weather. They are a variable you can plan around, and the window in which you have the most control closes the day required minimum distributions begin. Between now and then you decide how much comes out of your tax-deferred accounts and what rate you pay on it. After that, somebody else decides.

Add to that the icebergs below the surface, the tax on Social Security, what you pay for Medicare, and the cost of care nobody budgeted for, and the case for a forward-looking plan makes itself. Find someone who will look through the windshield with you while there is still road ahead.

Barry Watts is a retirement designer and tax strategist with WealthCare Retirement Solutions, the author of the book Watts on Wealth, and the host of a television program and radio show by the same name. Our YouTube channel is also called Watts on Wealth. If you are interested in listening to our podcast, it’s called The Truth about Taxes and Retirement and is available wherever you get your podcasts. Investment advisory services are offered through WealthCare Asset Management, LLC, an SEC registered investment advisor. Tax strategy, tax compliance, accounting, and insurance services are provided through its affiliate, WealthCare Tax Advisors, LLC. Remember: Investing involves risk, including the potential loss of principal, and past performance never guarantees future results. Any references to protection, safety, or lifetime income may refer to fixed insurance products. Insurance guarantees are backed by the financial strength and claims-paying ability of the issuing carrier. This article is for informational purposes only and should not be used as the basis for personal financial decisions without first consulting your personal qualified advisor. Case examples are illustrative of planning work performed for specific clients and are not a promise of similar results.

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